The Basel Handbook
First published:
ISBN: 9781904339557
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Explaining the Correlation in Basel II: Derivation and Evaluation
Christian Bluhm and Ludger Overbeck
Development and Validation of Key Estimates for Capital Models
Explaining the Correlation in Basel II: Derivation and Evaluation
Explaining the Credit Risk Elements in Basel II
Loss Given Default and Recovery Risk: From Basel II Standards to Effective Risk Management Tools
Assessing the Validity of Basel II Models in Measuring Risk of Credit Portfolios
Measuring Counterparty Credit Risk for Trading Products under Basel II
Implementation of an IRB-Compliant Rating System
Stress Tests of Banks’ Regulatory Capital Adequacy: Application to Tier 1 Capital and to Pillar 2 Stress Tests
Advanced Credit Model Performance Testing to Meet Basel Requirements: How Things Have Changed!
Designing and Implementing a Basel II Compliant PIT–TTC Ratings Framework
Basel II in the Light of Moody’s KMV Evidence
Basel II Capital Adequacy Rules for Retail Exposures
IRB-Compliant Models in Retail Banking
Basel II Capital Adequacy Rules for Securitisations
Regulatory Priorities and Expectations in the Implementation of the IRB Approach
Market Discipline and Appropriate Disclosure in Basel II
Validation of Banks’ Internal Rating Systems – A Supervisory Perspective
Rebalancing the Three Pillars of Basel II
Implementing a Basel II Scenario-Based AMA for Operational Risk
Loss Distribution Approach in Practice
An Operational Risk Rating Model Approach to Better Measurement and Management of Operational Risk
Constructing an Operational Event Database
Insurance and Operational Risk
INTRODUCTION
The implementation of correlation in the new regulatory capital framework has its roots in credit portfolio models such as CreditMetrics and the KMV model. In such models, correlation quantifies the linear dependence between obligors in a credit portfolio. There are basically two types of correlation applied, namely the asset correlation, quantifying the dependence between obligor’s asset-value processes, and the default correlation, as a measure of dependence between binary default events. In realistic credit risk models, default correlations live at a much smaller order of magnitude than asset correlations. In the new Basel Capital Accord, asset correlation as an input parameter in the basic risk weight formula constitutes an important driver of regulatory capital. This motivates a closer look at the correlation concept underlying the new Capital Accord.
DERIVATION OF CORRELATIONS IN BASEL II
The new Basel Capital Accord (see BCBS 2006), often called “Basel II”, is issued from the Basel Committee of Banking Supervision headquartered in the Bank of International Settlement (BIS) in Basel, Switzerland. Over recent years, regulators from many countries as well as
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